Housing depression raises recession risk

Builders slam on brakes, taking starts to 14-year low and permits to levels not seen since 1995; both readings fall short of forecasts.

By Chris Isidore, CNNMoney.com senior writer

October 17 2007: 2:01 PM EDT

NEW YORK (CNNMoney.com) -- Builders continued to slam the brakes on new homes in September, with levels hitting their lowest point in more than a decade.

The government's latest reading on the battered market Wednesday suggests the slump in home building could be much deeper than earlier estimates and could become a bigger drag on the overall economy than previously feared.

It also raised the prospect that the Federal Reserve will have to go ahead with interest rate cuts in an effort to avert the U.S. economy from falling into a recession.

The report showed the pace of housing starts plunged 10 percent in one month to an annual level of 1.19 million, compared to a 1.33 million rate in August. Economists surveyed by Briefing.com had forecast that starts would fall to an a rate of 1.29 million.

Housing starts - down nearly 31 percent from year-ago levels are now at their weakest level in 14 years.

Housing permits, which are seen as a sign of builders' confidence in the market, slumped 7 percent to an annual rate of 1.23 million from 1.32 million in August. Economists had looked for permits to slow to a 1.3 million pace.

The news on housing permits was equally bleak: The figures represent the lowest level of permits in more than 12 years, and the latest drop left permits down about 26 percent from a year earlier.And permits for single-family homes were even weaker, falling to a 15-year low. Every region of the country saw a drop in permits for single family homes in September, compared to the already soft levels seen in August.

The weak level of building suggests that housing is in an even deeper slowdown than originally expected, as the collapse in the mortgage market, falling home prices and an equally weak market for existing homes has dried up the supply of potential buyers.

Beyond the impact on home sales and prices, the sharp drop in home building could also prove to be a major drag on the economy because it depresses employment levels and overall economic activity.

According to Bill Hampel, chief economist for the Credit Union National Association, housing problems raise to 40 percent the chances that the economy could topple into recession.

"What I had always thought is that we would have a long, flat bottom for the housing market, but it is now apparent that the contraction is sharper than that," he said. "It raises the chance it [the slowdown in housing] will have an impact outside of the housing market."

Hampel said that he is expecting the Federal Reserve to respond to the housing slump by cutting rates at its Oct. 31 meeting. Economists' expectations of a rate cut had started to wane after a stronger than expected September employment report earlier this month. But Hampel said the crisis in housing now raises the need for at least one additional cut in rates, and sooner than later.

The Fed cited the slowdown in housing when it announced its first rate cut in four years in September.

In a speech Tuesday, Treasury Secretary Henry Paulson called the housing decline the most significant risk to the U.S. economy.

The report follows a survey released Tuesday that showed that home builders' confidence in the battered market for new homes fell to an all-time low in October, and a measure of their outlook for six months down the road remained at a record low level.

A forecast released Wednesday from the Mortgage Bankers Association shows that a glut of homes on the market and the greater difficulty many buyers will have getting loans will cause declines in home sales and prices to extend into next year.

Doug Duncan, the MBA's chief economist, said he is predicting a 22 percent drop in new home sales this year, followed by an additional 10 percent drop in 2008. National median home prices for new and existing homes are forecast to fall between 2 percent and 4 percent both this year and next.

But the slowdown in new home construction could be an important element to a longer-term recovery of the housing market. With weak demand for new home purchases, the only way to trim the glut of homes on the market is to choke off supply.

The National Association of Home Builders issued a statement saying the drop in housing starts is a necessary step, given the oversupply of homes on the market.

"We do expect some additional downward movement in housing production going into next year, at which point starts should begin to stabilize as sales turn upward in the second quarter," said David Seiders, chief economist for the trade group.

A separate Census Bureau report showed there were 180,000 completed new homes for sale at the end of August, just barely below the record 182,000 level seen in May. Further, the National Association of Realtors reports a record 4.6 million existing homes on the market at the end of August.

The downturn in housing and demand for new homes has hammered the results of the nation's top builders. Leading home builder D.R. Horton (Charts, Fortune 500) reported Tuesday that its fiscal fourth-quarter orders fell 39 percent, while the value of those orders plunged 48 percent.